The rules from AAOIFI's board of 18 religious advisers led by Chairman Sheikh Muhammad Taqi Usmani will make it harder for companies to issue Islamic debt at a time when borrowing is already shrinking because of the global credit crisis....``This is a paradigm shift and will make life difficult for chief financial officers used to the existing structures,'' Moody's Investors Service analyst Khalid Howladar said in a phone interview from Dubai today....Borrowers and their bankers until now created a fixed income for investors by promising to buy back the assets underlying sukuk at their face value on maturity, irrespective of whether the assets made or lost money, Moody's Howladar said. These types of agreements are banned under the tougher rules because Shariah demands buyers and sellers share profits or losses from their transactions.

``Blemishes'' have crept in that the industry must now ``rid'' itself of, AAOIFI's board of scholars said last month. As much as 85 percent of sukuk sold to date may not comply with all the precepts of Shariah, the board said.

The new rules force issuers of sukuk to legally transfer the ownership of assets to bondholders. The assets must be tangible rather than a cash flow.

``What the scholars are trying to do is make sukuk asset- backed rather than just asset-based,'' said Arul Kandasamy, the Dubai-based head of Islamic finance for Barclays Capital....Jebel Ali Free Zone FZE, Dubai's state-run operator of a business park adjoining the Jebel Ali port, raised $2 billion in the biggest sale of sukuk from the Gulf in the past six months. Buyers of the bonds have no legal claim on the underlying assets and have an ``implicit guarantee'' the issuer would cover any payment shortfalls, S&P said in a report in January....``The likely impact of this is that either the sukuk market becomes more based on Islamic securitizations or it bifurcates, with some sales becoming truly asset-backed and other issuers choosing to continue with existing structures,'' Moody's Howladar said.

On Thursday, Marketplace, from American Public Radio, had a good report on the controversy. You can listen here (lasts about 4 minutes). Or read the transcript. An excerpt from the transcript:

MP: Humayan Dar teaches Islamic finance at the CASS Business School. He says the sukuk, or Islamic bond, cleverly circumvents this rule in a number of different ways.

Humayan Dar: For example, sukuk holders receive ownership of an asset which is then leased to the issuer which offers a rental.

MP: But critics say that's just interest by another name... that bond is un-Islamic. A leading muslim scholar, Sheik Muhammed Taqi Usmani, says 80 percent of these bonds break the fundamentals laws of Islam. Tarek El Diwany, author of The Problem with Interest, says the sheik is right: The banks have been hoodwinking Muslim investors.

Tarek El Diwany: They are engaging in legal trickery in order to produce a fixed financial rate of return from the outset of the transaction. Many of them are -- not all of them.

MP: Special boards of Muslims scholars certify all the sukuk as islamic. The trouble is, says El Diwany, the banks pay those scholars -- sometimes handsomely. Rather like an investment bank paying a rating agency, which then gives its conventional bonds a triple-A. Hardly an independent opinion...

El Diwany: At the end of the day, it's a little bit much to expect a big banking organization to pay a scholar who says the bank's products are not permitted under Islamic law. It's not going to happen, is it?

For criticism of how the announcement was handled by Sheik Muhammed Taqi Usmani see "Mishandling Crises Leads to Disasters" by Lahem al Nasser writing in Asharq Al-Awsat. He writes, in part:

When Sheikh Muhammad Taqi Usmani, Chairman of the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) issued a statement to the media in which he said that 85 percent of sukuk (Islamic bonds) are non-Shariah compliant, it spread like wildfire causing disruption and confusion in the Islamic banking industry....The Chairman of the AAOIFI, Sheikh Muhammad Taqi Usmani could have clarified the statement and revealed which type of sukuk was referred to, its non-Shariah compliant aspect and also disclosed what percentage of overall Islamic bonds they comprise, in addition to how this dispute affects present and future issues.

I figure the AAOIFI woke up to the fact that anything financial instrument that guarantees a fixed return is an interest-bearing instrument. A bond is a bond is a bond, no matter how it is designed. When it comes to what these instruments are it's that simple. I figure that unless on appearances matter, these bonds do not meet the restriction against interest. The real question is, all interest also usury?

2 Comments:

Well, the bottom line is, as far as I can see, that anything "deficit-based" and involving "gearing" is unIslamic.

Examples of "deficit basis" are:

(a) credit creation by credit institutions based upon a small, Basel specified, amount of regulatory capital; and

(b) margined futures and options.

I stumbled into Islamic Finance - from a regulatory background, latterly as a Director of an oil futures exchange.

I did so because I was (and am) exploring new "asset-based" financial products based upon "ownership" of assets and their production/revenue streams using legal forms other than the "Corporation" (which is itself Islamically problematic in its risk and reward sharing characteristics.....)

So products such as Canadian Income Trusts; Exchange Traded Funds and REIT's, units in IPO's like Blackstone's where "partnership interests" are issued instead of shares in a Joint Stock Company, are all of interest.

When in 2001 I stumbled upon the UK "Open Corporate" Limited Liability Partnership (closer to the US LLC than the US LLP) I realised that this simple and infinitely flexible entity has possibilities for new partnership-based frameworks/ "enterprise models" within which a new - and probably optimal form of "unitisation" into "n'ths" is possible.

This article set out my realisation of the Islamic dimension of this new technique

http://www.opencapital.net/papers/chriscookjanarticle.pdf

but it met with blank incomprehension at best, and hostility at worst.

So it's interesting to see AAOFI's take on the institutionalised hypocrisy that passes for most "Islamic" finance these days.

Which is essentially putting lipstick on a pig.

My take, for what its worth, on the current global credit market situation is that we reached, "Peak Credit" a few months ago, and that the US credit market is finished for the foreseeable future.

The only hope for the US economy now, I believe, is a "Debt/Equity" swap on a massive scale into quasi REIT's on a massive scale.

Strange to relate, these new partnership-based vehicles are emerging because "they work", and I believe that it may even be the case that, after all, "Ethical is Optimal".